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Is Your Mutual Fund Politically Biased?

A recent study showed that partisan-leaning managers invest about 43% of assets in firms whose executives share the managers’ party affiliation.

If there’s anything we’ve learned over the past few years, it’s that there’s a lot of political bias in this country. So maybe it shouldn’t come as a surprise that mutual fund managers are susceptible, too.

A recent study shows that managers tend to invest in companies run by executives who share their politics—to the detriment of their fund investors. Prior research has already shown that fund managers prefer stocks from their own countries, their own cities and states, and the states where they grew up.

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The study was conducted by finance professors at San Diego State University and the University of Kansas and published in the Journal of Financial and Quantitative Analysis. The researchers looked at fund managers from 1,298 funds and executives of 16,655 firms in which the funds invested, culling political donation records from 1989 to 2016 to determine everyone’s political leanings.

A relatively simple analysis of the data found a striking pattern of favoritism. Partisan-leaning managers invested about 43% of assets in firms whose executives shared the managers’ party affiliation, and only about 33% of assets in firms whose executives had the opposite affiliation. After controlling for a variety of fund, company and other characteristics, the researchers found that overall, both Republican and Democratic fund managers invested 4% to 7% more of their fund’s assets in companies managed by politically like-minded executives than did fund managers who had opposite political leanings. Furthermore, managers were more likely to hold on longer to losing stocks of firms run by executives who shared their partisan orientation, the research found.

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No insider info. Investing along party lines might be okay if managers got a competitive edge by hobnobbing—say, in the neighborhood, at the club or at social events—with like-minded execs. But the researchers didn’t find any enhanced information channels along those lines or any increased familiarity with the companies. What they found was a simple preference, long documented in social psychology research, for people similar to themselves—a favoritism that leads people to confer superiority to members of their own group. In this case, that led the managers to consider firms run by executives whose politics were similar to their own to be superior investments.

Fund managers were also more likely to invest in firms with politically similar management when their own political party was in power. This tendency dovetails with prior research that found investors perceive the markets to be less risky when their own party is in power.

What price do investors pay for casting their lot with politically biased fund managers? Some results from the research showed that these funds perform slightly worse than comparable funds with no political bias; other results suggested the returns were comparable, says study coauthor Yaoyi Xi, a finance professor at San Diego State. What is clear is that the funds with more partisan holdings tended to have significantly higher risks, measured by volatility. “This pattern does not fit well with the principle that investors should expect higher returns when bearing greater risks,” says Xi.

The good news for anyone who prefers an unbiased manager is that political bias is muted in managers with more experience, and it becomes less evident when corporate information is readily available. So, as always, look for managers with long and solid track records, who aren’t likely to take fliers on companies that are less than forthcoming about business results. And consider index funds if you want to excise manager bias of any sort from your portfolio.

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